Showing papers in "The American Economic Review in 1996"

The Twin Crises: The Causes of Banking and Balance-Of-Payments Problems

Abstract: In the wake of the Mexican and Asian currency turmoil, the subject of financial crises has come to the forefront of academic and policy discussions. This paper analyzes the links between banking and currency crises. We find that: problems in the banking sector typically precede a currency crisis--the currency crisis deepens the banking crisis, activating a vicious spiral; financial liberalization often precedes banking crises. The anatomy of these episodes suggests that crises occur as the economy enters a recession, following a prolonged boom in economic activity that was fueled by credit, capital inflows and accompanied by an overvalued currency.

R&D Spillovers and the Geography of Innovation and Production

Abstract: Previous research has indicated that investment in R&D by private firms and universities can lead to knowledge spillover, which can lead to exploitation from other third-party firms. If the ability of these third-party firms to acquire knowledge spillovers is influenced by their proximity to the knowledge source, then geographic clustering should be observable, especially in industries where access to knowledge spillovers is vital. The spatial distribution of innovation activity and the geographic concentration of production are examined, using three sources of economic knowledge: industry R&D, skilled labor, and the size of the pool of basic science for a specific industry. Results show that the propensity for innovative activity to cluster spatially is more attributable to the influence of knowledge spillovers and not merely the geographic concentration of production. (SFL)

Entry, Exit, Growth, and Innovation over the Product Life Cycle

Abstract: Regularities concerning how entry, exit, market structure, and innovation vary from the birth of technologically progressive industries through maturity are summarized. A model emphasizing differences in firm innovative capabilities and the importance of firm size in appropriating the returns from innovation is developed to explain the regularities. The model also explains regularities regarding the relationship within industries between firm size and firm innovative effort, innovative productivity, cost, and profitability. It predicts that over time firms devote more effort to process innovation but the number of firms and the rate and diversity of product innovation eventually wither.

Trust in Large Organizations

Abstract: Several authors suggest that trust is an important determinant of cooperation between strangers in a society, and therefore of performance of social institutions. We argue that trust should be particularly important for the performance of large organizations. In a cross-section of countries, evidence on government performance, participation in civic and professional societies, importance of large firms, and the performance of social institutions more generally supports this hypothesis. Moreover, trust is lower in countries with dominant hierarchical religions, which may have deterred networks of cooperation trust hold up remarkably well on a cross-section of countries.

International Measures of Schooling Years and Schooling Quality

Abstract: This study provides an update on measures of educational attainment for a broad cross section of countries. In our previous work (Barro and Lee, 1993), we constructed estimates of educational attainment by sex for persons aged 25 and over. The values applied to 129 countries over five-year intervals from 1960 to 1985. The schooling figures indicated the fractions of the adult population for whom the highest level of attainment fell into seven standard classifications: no formal education, incomplete primary, complete primary, first cycle of secondary, second cycle of secondary, incomplete higher, and complete higher. Information by country about the typical duration of each level of schooling then allowed us to compute the number of years of attainment achieved by the average person in each country at the various levels and in total schooling. The estimation procedure began with census information on school attainment for males and females aged 25 and over. These data came from individual governments, as compiled by UNESCO and other sources. The census values provided benchmark numbers for a subset of the dates (roughly 40 percent) that we were considering. Missing cells were filled in by using school-enrollment ratios by sex at various levels of schooling. The basic idea is that the enrolled population is the flow that adds over time to the prior stock of schooling to determine the subsequent stocks. In this manner, full estimates of educational attainment were obtained at five-year intervals for most countries from the benchmark figures for one or more years and from the reasonably complete data on school-enrollment ratios. The schooling figures that we constructed have clear advantages over the educational variables that have been used in many previous cross-country investigations of the effects of schooling. These studies have typically relied on school-enrollment ratios or adult literacy rates, concepts that do not correspond to the stock of human capital that influences current decisions about fertility, health, and so on. For these reasons, the new estimates have already been used in many empirical studies.' Despite these advantages, the data assembled in our previous study had a number of shortcomings. First, the available census information motivated an initial concentration on the adult population aged 25 and over; that is, the data were most plentiful for this age group. For many developing countries, however, a large portion of the labor force is younger than 25. For that reason, the present study provides estimates of school attainment for the population aged 15 and over. Our previous fill-in procedure used the UN's readily available figures on the gross schoolenrollment ratio, the ratio of all persons enrolled in a given level of schooling to the population of the age group that national regulation or custom dictates should be enrolled at that level. For example, the total registered students in primary school are typically compared with the population aged 6-11 years. A tendency for students to repeat grades or to return after previously dropping out means that the gross ratio will overstate the accumulation of human capital. One indication of

Business Cycles and Labor-Market Search

Abstract: The quantitative implications of labor-market search for economic fluctuations are evaluated in the context of a real-business-cycle model. Incorporating labor-market search into the model is found to improve its empirical performance along several dimensions. In particular, hours now fluctuate substantially more than wages and the contemporaneous correlation between hours and productivity falls. In addition, the model replicates the observation that output growth displays positive autocorrelation at short horizons. Overall, the empirical results suggest that the labor-market-search environment embodies a quantitatively important propagation mechanism. Copyright 1996 by American Economic Association.

Globalization, Outsourcing, and Wage Inequality

Abstract: There is considerable debate over whether international trade has contributed to the declining economic fortunes of less skilled workers. One issue that has become lost in the current discussion is how firms respond to import competition and how these responses, in turn, are transmitted to the labor market. In previous work, we have argued that outsourcing, by which we mean the import of intermediate inputs by domestic firms, has contributed to an increase in the relative demand for skilled labor in the United States. If firms respond to import competition from low-wage countries by moving non- skill-intensive activities abroad, then trade will shift employment towards skilled workers within industries. In this paper, we extend our previous work by combining new import data from the revised NBER trade database with disaggregated data on input purchases from the Census of Manufactures. We construct industry-by-industry estimates of outsourcing for the period 1972-1990 and reexamine whether outsourcing has contributed to an increase in relative demand for skilled labor. Our main finding is that outsourcing can account for 31-51% of the increase in the relative demand for skilled labor that occurred in U.S. manufacturing industries during the 1980s, compared to our previous estimate of 15-33%.

Multinationals, Linkages, and Economic Development

Abstract: This paper explores how multinationals affect underdeveloped regions through the generation of linkages. It is shown that the linkage effect of multinationals on the host country is more likely to be favorable when the good that multinationals produce uses intermediate goods intensively, when there are large costs of communication between the headquarters and the production plant, and when the home and host countries are not too different in terms of the variety of intermediate goods produced. If these conditions are reversed, then multinationals could even hurt the developing economy, formalizing the idea that multinationals may create enclave economies within developing countries. Copyright 1996 by American Economic Association.

Veblen Effects in a Theory of Conspicuous Consumption

Abstract: The authors examine conditions under which 'Veblen effects' arise from the desire to achieve social status by signaling wealth through conspicuous consumption. While Veblen effects cannot ordinarily arise when preferences satisfy a 'single-crossing property,' they may emerge when this property fails. In that case, 'budget' brands are priced at marginal cost, while 'luxury' brands, though not intrinsically superior, are sold at higher prices to consumers seeking to advertise wealth. Luxury brands earn strictly positive profits under conditions that would, with standard formulations of preferences, yield marginal-cost pricing. The authors explore factors that induce Veblen effects and they investigate policy implications. Copyright 1996 by American Economic Association.

Children and their parents labor supply: evidence from exogenous variation in family size.

Abstract: Although theoretical models of labor supply and the family are well developed there are few credible estimates of key empirical relationships in the work-family nexus. This study uses a new instrumental variable the sex composition of the first two births in families with at least two children to estimate the effect of additional children on parents labor supply [in the United States]. Instrumental variables estimates using the sex mix are substantial but smaller than the corresponding ordinary least squares (OLS) estimates. Moreover unlike the OLS estimates the female labor supply effects estimated using sex-mix instruments appear to be absent among more educated women and women with high-wage husbands. We also find that married women who have a third child reduce their labor supply by as much as women in the full sample while there is no relationship between wives child-bearing and husbands labor supply. (EXCERPT)

Heterogeneity, Stratification, and Growth: Macroeconomic Implications of Community Structure and School Finance

Abstract: This paper examines how socioeconomic stratification and alternative systems of education finance affect inequality and growth Agents interact through local public goods or externalities (school funding, neighborhood effects) and economywide linkages (complementary skills, knowledge spillovers) Sorting families into homogeneous communities often minimizes the costs of existing heterogeneity but mixing reduces heterogeneity faster Integration, therefore, tends to slow down growth in the short run yet raise it in the long run A move to state funding of education presents society with a similar intertemporal trade-off Local and global complementarities play major roles in determining the efficient social and educational structures Copyright 1996 by American Economic Association

The Swing Voter's Curse

Abstract: The authors analyze two-candidate elections in which some voters are uncertain about the realization of a state variable that affects the utility of all voters. They demonstrate the existence of a swing voter's curse: less informed indifferent voters strictly prefer to abstain rather than vote for either candidate even when voting is costless. The swing voter's curse leads to the equilibrium result that a substantial fraction of the electorate will abstain even though all abstainers strictly prefer voting for one candidate over voting for another. Copyright 1996 by American Economic Association.

A Signaling Explanation for Charity

Abstract: This article examines a novel but plausible motive for charitable giving. Charitable donations which are observable can signal wealth or income. The signaling equilibrium of charitable donations has attractive properties. Donations increase proportionally with population size. Governmental funding for public goods affects private charity only through an income effect. Crowding out need not be complete. Income redistribution is generically nonneutral. Increasing the spread between the poorest and richest person in a community tends to increase private donations. Our theory are based on the assumption that people are willing to make charitable donations even if they will not increase provision of the public good. The data on charitable giving support the hypothesis that donors donate at least partly for signaling purposes rather than only to aid the recipient or to obtain satisfactions unrelated to status. Though charitable organizations usually report donations within categories, thus not allowing perfect revelation, for analytical tractability we shall consider an equilibrium with perfect revelation and a continuum of types, as characterized in George J. Mailath (1987) and Norman J. Ireland (1994).

Auctions Versus Negotiations

Abstract: Which is the more profitable way to sell a company: an auction with no reserve price or an optimally-structured negotiation with one less bidder? We show under reasonable assumptions that the auction is always preferable when bidders' signals are independent. For affiliated signals, the result holds under certain restrictions on the seller's choice of negotiating mechanism. The result suggests that the value of negotiating skill is small relative to the value of additional competition. The paper also shows how the analogies between monopoly theory and auction theory can help derive new results in auction theory. (JEL D44, G34) There are close analogies between standard price theory and the theory of auctions. In an absolute English auction, in which the price rises continuously until only one bidder remains and the seller is required to accept the final bid, the sale price equals the lowest competitive price at which supply equals demand. In the theory of optimal auctions the seller is treated as a monopolist who can choose any

Technical Change and Human-Capital Returns and Investments: Evidence from the Green Revolution

Abstract: Panel and time-series data describing the green-revolution period in India are used to assess the effects of exogenous technical change on the returns to schooling, the effects of schooling on the profitability of technical change, and the effects of technical change and school availability on household schooling investment. The results indicate that the returns to (primary) schooling increased during a period of rapid technical progress, particularly in areas with the highest growth rates. Such increases induced private investment in schooling, net of changes in wealth, wages, and the availability of schools, and school expansion importantly increased levels of schooling. Copyright 1996 by American Economic Association.

Reciprocal Exchange: A Self-Sustaining System

Abstract: Reciprocal exchange, or gift exchange, remains a widespread means of obtaining goods and services. This paper examines the persistence of reciprocal exchange by formalizing the interaction between self-enforcing exchange agreements and monetary market exchange. When more people engage in reciprocal exchange, market search costs increase, reciprocity is easier to enforce and yields higher utility. Thus, personalized exchange can persist even when it is inefficient. Conversely, large markets can destroy reciprocity when reciprocal exchange is efficient. The results characterize the use of personal "connections" as a system of reciprocal exchange and explain the disappearance of reciprocity when tribes encounter markets. (JEL D23, D51, L14, 017)

Migration with endogenous moving costs.

Abstract: We study a dynamic model of labor migration in which moving costs decrease with the number of migrants already settled in the destination. This assumption is supported by sociological studies of migrant networks. With endogenous moving costs migration occurs gradually over time. Once it starts it develops momentum and migratory flows may increase even as wage differentials narrow. In addition migration tends to follow geographical channels and low-moving-cost individuals migrate first. These patterns are consistent with historical evidence from the Great Black Migration of 1915-1960 [in the United States] much of which cannot be reconciled with existing migration models. (EXCERPT)

Dynamic Capital Structure under Managerial Entrenchment

Abstract: This paper develops a model in which managers voluntarily choose debt to credibly constrain their own future empire-building. Dynamically consistent capital structure is derived as the optimal response in each period of partially entrenched managers trading off empire-building ambitions with the need to ensure sufficient efficiency to prevent control challenges. A policy of capital structure coordinated with dividends follows naturally, as do implications for the level, frequency, and maturity structure of debt as a function of outside investment opportunities. Additionally, the model yields new testable implications for security design, and changes in debt and empire-building over managerial careers. Copyright 1996 by American Economic Association.

The International Transmission of Financial Shocks: The Case of Japan

Abstract: One of the more dramatic financial events of the late 1980s and early 1990s was the surge in Japanese stock prices that was immediately followed by a very sharp decline of more than 50 percent. While the unprecedented fluctuations in Japanese stock prices were domestic financial shocks, the unique institutional characteristics of the Japanese economy produce a framework that is particularly suited to the transmission of such shocks to other countries through the behavior of the Japanese banking system. The large size of Japanese bank lending operations in the United States enables us to use U.S. banking data to investigate the extent to which this domestic Japanese financial shock was transmitted to the United States, as well as to identify a supply shock to U.S. bank lending that is independent of U.S. loan demand. We find that binding risk-based capital requirements associated with the decline in the Japanese stock market resulted in a decline in commercial lending by Japanese banks in the United States that was both economically and statistically significant. This finding has added importance given the severe real estate loan problems currently faced by Japanese banks. How Japanese bank regulators decide to resolve these problems will have significant implications for credit availability in the United States as well as in other countries with a significant Japanese bank presence.

The Evolution of Social Norms in Common Property Resource Use

Abstract: The problem of extracting commonly owned renewable resources is examined within an evolutionary-game-theoretic framework. It is shown that cooperative behavior guided by norms of restraint and punishment may be stable in a well-defined sense against invasion by narrowly self-interested behavior. The resource-stock dynamics are integrated with the evolutionary-game dynamics. Effects of changes in prices, technology, and social cohesion on extraction behavior and the long-run stock are analyzed. When threshold values of the parameters are crossed, social norms can break down leading generally to the lowering of the long-run stock and possibly to its extinction. Copyright 1996 by American Economic Association.

State infrastructure and productive performance

Abstract: Recent research on productivity growth has focused on public infrastructure and its impact on economic growth and productivity. The authors construct a model of firms' technology and behavior, taking advantage of the analytical framework provided in the cost-function-based applied production-theory literature, and apply it to state-level data for U.S. manufacturing. They find that infrastructure investment provides a significant return to manufacturing firms and augments productivity growth. The net benefits of infrastructure investment may or may not be positive, depending upon the social costs of infrastructure investment and the relative growth rates of output and infrastructure. Copyright 1996 by American Economic Association.

How Do Senators Vote? Disentangling the Role of Voter Preferences, Party Affiliation, and Senate Ideology

Abstract: This paper develops a methodology for consistently estimating the relative weights in senator utility functions, despite the fact that senator ideologies are unobserved. The empirical results suggest that voter preferences are assigned only one quarter of the weight in senator utility functions. The national 'party line' also has some influence but the senator's own ideology is the primary determinant of roll-call voting patterns. These results cast doubt on the empirical relevance of the median voter theorem. Estimation of the model requires only roll-call voting data, making it widely applicable. Copyright 1996 by American Economic Association.

Income Risk, Borrowing Constraints, and Portfolio Choice

Abstract: Economic theory suggests that uninsurable income risk and the expectation of future borrowing constraints can reduce the share of risky assets in a household's portfolio. If the utility function exhibits decreasing absolute risk aversion and decreasing prudence, an individual will reduce his exposure to rate-of-return risks when confronted with other independent risks. If there are transaction costs, the expectation of future borrowing constraints should induce individuals to keep a lower proportion of their wealth in the form of illiquid and risky assets. The authors find support for these propositions in a cross-section of Italian households. Copyright 1996 by American Economic Association.

Sources of Inefficiency in a Representative Democracy: A Dynamic Analysis

Abstract: This paper studies the efficiency of policy choice in representative democracies. It extends the citizen-candidate model of democratic policy-making to a dynamic environment. Equilibrium policy choices are shown to be efficient in the sense that in each period, conditional on future policies being selected through the democratic process, there exists no alternative current policy choices which can raise the expected utilities of all citizens. However, policies that would be declared efficient by standard economic criteria are not necessarily adopted in political equilibrium. The paper argues that these divergencies are legitimately viewed as "politicalfailures."

How (not) to sell nuclear weapons

Abstract: We consider situations where a sale affects the ensuing interaction between potential buyers. These situations are modeled by assuming that an agent who does not acquire the object for sale incurs an identity-dependent externality. We construct a revenue-maximizing auction for the seller. We observe that: 1) outside options and participation constraints are endogenous. 2) The seller extracts surplus also from agents who do not obtain the auctioned object. 3) The seller is better-off by not selling at all (while obtaining some payments) if externalities are much larger than valuations.

The Spirit of Capitalism and Stock-Market Prices

Abstract: In existing theory, wealth is no more valuable than its implied consumption rewards. In reality, investors acquire wealth not just for its implied consumption but for the resulting social status. Max M. Weber (1958) refers to this desire for wealth as the spirit of capitalism. The authors examine, both analytically and empirically, implications of Weber's hypothesis for consumption, savings, and stock prices. When investors care about relative social status, propensity to consume and risk-taking behavior will depend on social standards and stock prices will be volatile. The spirit of capitalism seems to be a driving force behind stock-market volatility and economic growth. Copyright 1996 by American Economic Association.

Capital Market Imperfections and Countercyclical Markups: Theory and Evidence

Abstract: During recessions, output prices seem to rise relative to wages and raw-material prices. One explanation is that imperfectly competitive firms compete less aggressively during recessions. That is, markups of price over marginal cost are countercyclical. The authors present a model of countercyclical markups based on capital-market imperfections. During recessions, liquidity-constrained firms boost short-run profits by raising prices to cut their investments in market share. The authors provide evidence from the supermarket industry in support of this theory. During regional and macroeconomic recessions, more financially constrained supermarket chains raise their prices relative to less financially constrained chains. Copyright 1996 by American Economic Association.

Industry differences in the persistence of firm-specific returns

Abstract: Some firms such as Kellogg, Nestle, Hewlett-Packard, and Boeing have consistently earned significantly higher returns than their immediate competitors. Why do intraindustry rents persist for these firms? Competition typically erodes these rents, as evidenced by the strong convergence of firm profitability to the industry mean, illustrated in Figure 1. I claim that the persistence of these firmspecific rents depends at least partly on industry economic structure (similar to Richard E. Caves and Michael E. Porter's [1977] "mobility barriers"), so the rents are more persistent in some industries than others. In this paper I test which of the theoretical industry factors are significant. To support my claim I also show that the persistence of abnormal returns differs widely and systematically across industries. For example, an industry with highly persistent profitability differences is the American automobile industry in the 1970's, as illustrated by Figure 2, which graphs differences in returns on assets (ROA's) over time. Throughout the 1970's, General Motors maintained a persistent, significant profitability advantage over Ford, while Ford held a persistent advantage over Chrysler. This situation did change later, but it is still true that, during the 1970's, there was no apparent convergence of profitability differences among the big-three auto makers. A comparison of Figures 1 and 2 suggests that the economy-wide result of Figure 1 is merely an average over very different industries with convergence rates ranging from almost zero (as in automobiles in the 1970's) to very rapid. My methods for estimating persistence of above-average returns improve on previous studies in several ways. First, I only consider the persistence of returns around the industry mean. The persistence of this intra-industry or "firm-specific" rent rather than total rent has not been previously investigated. Yet the factors affecting firm-specific rents need not be the same as those affecting industry rents. Second, I estimate persistence in several ways. Finally, I use a wider range of explanatory variables than earlier studies. This study is structured as follows. Section I explains the concept of persistent firmspecific rents. Later sections specify the empirical model and estimate persistence by industry (Section II), theoretically relate industry factors to these varying persistence estimates (Section III), discuss cross-sectional regression estimates (Section IV), and provide conclusions (Section V).